[The Editors' Verdict] The Cost of Expansionary Fiscal Policy: It May Be Prices, Not Taxes

Spending Expansion Without a Revenue Enhancement Plan
Fiscal Discipline Needed to Prevent Inflation

Expansionary fiscal policy is an important tool for responding to crises. The problem arises when it becomes not an exceptional measure, but a constant stance-essentially, a policy "constant." Recently, as the government has made it clear that it will maintain an expansionary fiscal stance over the medium term, fiscal management is shifting from a means of responding to economic cycles to a matter of policy philosophy. The question that must be asked at this point is simple: How will this fiscal spending be financed?

President Lee Jae-myung is arriving for his first day of work at the Blue House main building, where the presidential office relocation was completed on the 29th. Photo by Yonhap News

The head of the Bank of Korea's Economic Research Institute recently warned in an academic lecture that if spending increases are prolonged without a solid revenue base, the public may end up shouldering what is known as an "inflation tax." This is a pathway that is well explained in economic theory. Of course, not every fiscal expansion or government bond issuance leads directly to higher prices. However, if fiscal expansion financed by government bonds continues without tax increases or spending adjustments, and if demand pressures become stronger than expected or monetary policy responses are constrained, there may be a greater incentive to reduce the real value of debt through inflation. This is a way of shifting the burden through a decline in real purchasing power, rather than through explicit tax hikes.

In general, when fiscal expansion is accompanied by increased revenue, the rise in government spending is offset by adjustments in private disposable income, limiting any sharp increase in net demand. However, in the current debate, while the sustainability of increased spending under expansionary fiscal policy seems relatively clear, there is no concrete roadmap for strengthening the medium- to long-term revenue base to support it. This suggests a risk that fiscal expansion could become entrenched as a structural "constant" rather than just a short-term response.

In this process, it is also possible that the room for maneuver in monetary policy could narrow. The more fiscal policy relies on debt, the more the central bank must be mindful not only of price stability but also of the government bond market and the government's interest burden. As the impact of interest rate hikes on government finances grows, monetary policy decisions inevitably become more politically sensitive. If this structure persists, monetary policy aimed at price stability could be constrained, or at least perceived as such. In theory, this could lead to what is known as "fiscal dominance."

The macroeconomic environment is also far from favorable. In a situation of high exchange rate volatility, exchange rates can amplify inflation expectations through import prices. If this is combined with policy signals suggesting that expansionary fiscal policy will be prolonged, the market may become even more sensitive to inflation. Once inflation expectations begin to move, the policy cost of stabilizing actual prices rises significantly. This is the scenario central banks are most wary of.

The expansionary fiscal policy itself is not the problem. The government's active role is necessary during economic downturns. However, if there is no credible roadmap for when and how expansionary fiscal policy will be normalized, the cost will inevitably fall on the public. This is likely to appear not as explicit tax increases or spending cuts, but in the more opaque form of rising prices.

Therefore, what is needed now is not a sudden shift in fiscal direction, but fiscal discipline. Without fiscal rules with real binding power, enhanced credibility of medium-term fiscal plans, and ex-ante verification mechanisms for total budget size, expansionary fiscal policy can easily become politicized, and once fiscal spending increases, it can become difficult to reverse. The effects of expansionary fiscal policy are determined by today's choices, but the costs appear with a time lag. And how that burden ultimately materializes depends on the discipline underpinning current fiscal management.